Scan a 10-Q filing and the words "derivatives" and "losses" tend to jump off the page and resonate in investors' minds in a way that the term "unrealized loss" does not, as General Electric discovered recently. GE's stock fell some 10% over the last 10 days of May in a move that some institutional investors say is attributable to the corporate having to disclose the fair value of derivatives on its balance sheet, in accordance with the Financial Accounting Standards Board's accounting rule 133. For most corporates this is the first calendar year in which they must report derivatives positions under FAS 133.
In last month's 10-Q filing GE revealed it has taken a $1.2 billion unrealized loss on its derivatives positions in the first quarter. Officials at GE declined all comment.
"When we heard the news that GE Capital had lost $1.2 billion in derivatives we sold," said a New York-based institutional investor. In response to a flood of anxious calls from investors and analysts, Mark Vachon, head of investor relations at GE, sent an e-mail May 26 providing clarification on the derivatives positions. "The $1.2 billion doesn't represent any realized net loss now, or one that will be realized in the future," Vachon said in the e-mail, a copy of which was obtained by DW. "The economic match funded assets are not permitted to be marked to market under FASB 133. If they were, there would be a corresponding $1.2 billion gain," the note continued.
"When we saw Vachon's e-mail we were fine about it and reassured our clients that this was simply not an issue," said Nicholas Heymann, senior v.p. of research at Prudential Securities in New York. "Vachon reacted and he reacted fast," added an analyst at a European bank in New York. "The FAS 133 was a curve ball and he had to react quickly to quash the rumors that the firm had actually lost money."
"GE handled the situation well in my opinion," says the European bank analyst. "Anyone paying attention to its 10-Q filings would have known that this was coming and, if they'd been really clever, they could have exploited the sell off."
In its 10-Q filings GE reveals in detail its derivative use for hedging purposes, disclosing the use of interest-rate swaps, currency forwards, currency swaps, futures and exotic and plain vanilla options, primarily to manage its funding requirements. GE Capital also uses equity derivatives to manage market investments, which do not qualify as hedges under the FAS 133 accounting rules.
The 10-Q also states that, as a result of hedging practices and the firm's philosophy to remain market neutral, the principal risk it faces is counterparty credit risk. As a result, the firm is presently engaged in an ongoing review of its counterparty credit criteria to monitor counterparty credit risk more actively.
